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Does the Social Safety Net Make Us Lazy?

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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There’s an eternal debate about how government can best help people when they aren't doing well economically.

One side says that if government provides you with a safety net, you will become lax and complacent, and you won’t try as hard. Only the threat of the yawning abyss, the thinking goes, will galvanize you to get off your butt and give it your all. For example, during the 2012 election campaign vice presidential candidate Paul Ryan said:

We don't want to turn the safety net into a hammock that lulls able-bodied people into lives of dependency and complacency, that drains them of their will and their incentive to make the most of their lives

Another side says that if government provides a safety net, people will be willing to take more risks. In his 2014 State of the Union speech, President Barack Obama said that the government’s role is to “give people the tools to make something of themselves.”  Knowing that society has your back, the thinking goes, emboldens people to go for the gold. It’s a question of whether effort or risk-taking is more important.

In past decades, this debate has been mostly about poor people. But in the future, the discussion may shift to how to encourage entrepreneurship. Even as tech startups continue to grab headlines, the U.S.’s underlying business dynamism has been eroding. For their part, other countries would like to increase their levels of entrepreneurship. The question is: How?

The “effort” school of thought says that a strong safety net discourages entrepreneurship. That school is represented by a 2012 theoretical paper by MIT economist Daron Acemoglu, James Robinson of Harvard and Thierry Verdier of the Paris School of Economics. Acemoglu and Robinson are usually thought of as being more on the liberal side of the spectrum, since their main body of work focuses on the importance of building good national institutions. But in this paper, they warn that a social safety net could have the drawback of reducing entrepreneurship. From their abstract:

Because of their more limited inequality and more comprehensive social welfare systems, many perceive average welfare to be higher in Scandinavian societies than in the United States. Why then does the United States not adopt Scandinavian-style institutions?...A greater gap of incomes between successful and unsuccessful entrepreneurs (thus greater inequality) increases entrepreneurial effort...some countries will opt for a type of “cutthroat” capitalism that generates greater inequality and more innovation and will become the technology leaders, while others will free-ride on the cutthroat incentives of the leaders and choose a more cuddly form of capitalism.

As you might expect, in the model the authors construct, effort -- not willingness to bear risk -- is the main input into entrepreneurial activity. Note that Acemoglu et al. are actually claiming that inequality has a positive effect -- it makes people work harder, because they’re more afraid to be poor! 

But it’s easy to see that if entrepreneurship depends on willingness to take risk, this conclusion could be reversed. Poor people are very risk-averse, because losing money means starving. Since starting a business involves a lot of risk, this might mean that a social safety net -- which prevents you from ever starving -- would give poor entrepreneurs the confidence to take risks and start businesses.

Although they don’t explicitly construct such a theory, economists Johan Hombert, an economist at HEC Paris, Antoinette Schoar of MIT, and David Sraer at the University of Califorina, Berkeley, recently found evidence that broadly fits the alternative story. The authors take advantage of a 2002 French government reform that gave extended jobless benefits to unemployed people who started their own companies. Not only would this let unemployed people keep their benefits while launching companies, but if the companies failed, the benefits would extend even further in time. Basically, the French government decided to treat entrepreneurship like any other job, with respect to benefits. In doing so, the government offered a backstop to unemployed entrepreneurs, offering them a safety net should they fail.

Hombert et al. find that the rate of entrepreneurship increased by about 10 percent, across all industries. More importantly, they found that the businesses created by people who were helped by the new law were just as high-quality as other new businesses, in terms of job creation, growth and survival rates. Actually, the entrepreneurs helped by the new policy reported higher levels of ambitiousness than other entrepreneurs -- a measure that sounds hokey, but is typically correlated with future business growth.

So in this case, a more “cuddly” form of capitalism didn’t reduce the incentive for entrepreneurship -- it increased it. That hints that, in France at least, the main constraint on entrepreneurial activity isn't lack of effort, but too much risk. The theory of Acemoglu et al., in other words, might just not describe what’s going on in France.

What about the U.S.? Harvard Business School professor Gareth Olds has found evidence that is strikingly similar to Hombert et al. In a 2014 study, he found that food-stamp assistance makes people significantly more likely to start businesses. Again, the data supports the hypothesis that “cuddly capitalism” boosts risk-taking, rather than discouraging it.

This suggests a way for us to attack the entrepreneurship deficit. In his 2008 book, "The Great Risk Shift," Jacob Hacker documents how Americans have been forced to take on more and more personal risk -- medical bankruptcies, unemployment and retirement finances all loom larger than they used to. Maybe this is scaring Americans away from entrepreneurship -- forcing them to forgo big dreams because the financial danger of failure is too great. Perhaps if the government did more to limit these risks, we would see the entrepreneurship decline reverse itself.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Noah Smith at nsmith150@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net